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One good reason not to buy a jetcar

The blockchain is the flying car of finance - and it has finally arrived. But before we take the wheel, we need to figure out how to regulate its use.

In 1969 a TV programme in the UK called "Tomorrow's
World" demonstrated a computer-run banking system which made payments between
banks and shops via the phone network.

Described as "the electronic equivalent
of many thousand ledger clerks" the programme noted that £6 million of payments
were 'bounced' each year as a result of cheques being written out for accounts
that did not have the funds to support them.

"The electronic system is 'bounce-proof'," said
reporter Derek Cooper. "It simply won't work unless you have cash or credit at
the bank."

47 years later, we have not yet reached that
reality. The system, at least in the UK, is still run on an overnight batch
process; real-time processing still belongs to the future.

But if you do want to develop some of the other
inventions showcased on Tomorrow's World - such as a flying car - there are
several infrastructural developments that will need to happen at the same time
in order to support it. On top of the operational aspects (where do you
refuel?) there is the question of where and how you would be regulated to fly,
and how the authorities would go about monitoring you.

This question is just as pertinent for the next big
thing in finance - the blockchain. A distributed ledger, similar in its
function to the computer system described on Tomorrow's World, the blockchain
could help banks to settle transactions instantaneously. This would
remove the problem of 'bounced' payments - and therefore the need for reconciliation.

So what will need to happen in the rest of the
financial infrastructure if that system is to operate? Clearly, just as with
the existing payments network, internal accounting and banking platforms would
have to be able to record the transactions in real time or as close as a
distributed ledger will transact to real time.

If we expand it out into the securities world, as
BNP Paribas and 41 other banks are successfully doing with R3CEV 1, one
has to ask - how will it be regulated? Some blockchains are built to
transact between commercial banks. Others, such as the one proposed by Setl,
are developed to work between central banks and commercial banks.

The greatest advantage of the blockchain is that it
is always on. Without the capacity for error or disagreement in payment versus
delivery - because they are resolved at the point of execution - there can be a
system that operates 24 hours a day, seven days a week, in real time.
If that occurs, however, then real-time, full-time
regulation is also necessary.

The distributed ledger provides records of every
transaction that are fully verified, which could be a valuable resource to
regulators. They could be alerted when a transaction is attempted but rejected.
Cumulatively, a regulator could develop a record that details which firms are
performing more effectively, indelibly on a blockchain. It could ask a bank to
improve the rate of failed payments and begin monitoring operational risk.

With the blockchain, a regulator can effectively see a bank starting to get into
trouble and make the necessary policy adjustments in order to help it - by
injecting some emergency liquidity, for example.

The effects of this would mirror what is happening
in the insurance sector, where the prevalence of data around client activity is
allowing firms to move from 'protection' to 'prevention': technology can
monitor risks within the home and then allow the homeowner to be alerted before
a fire spreads or a flood causes excessive damage.

However this brings us back
to Tomorrow's World: there are still plenty of structural changes to be made if
we are to continue developing and rolling out distributed ledgers for payment
and trading systems. All market participants, regulators and other stakeholders
must all be onboard and involved in order to ensure that the future is evenly
distributed - and that the blockchain can make a smooth landing.

[1]A firm
that is building a consortium of finance houses to standardise an interbank
mechanism